Mineral interest ownership has much more flexibility than traditional real estate. A single property can be divided among many different owners, each with independent ownership of their interest. Due to the flexible nature of minerals, clients can customize an investment level that works best for them, especially when part of a 1031 exchange where every dollar counts as you work to preserve your capital gains.

Clients have often turned to royalties when faced with an odd amount left over in their exchange after acquiring a piece of traditional real estate. This left-over amount is commonly referred to as “boot” and royalties can be a solution to make sure your exchange is maximized.

From a return standpoint, oil & gas royalty owners typically see annual yields that are about double when compared to today’s triple-net real estate market. Because the royalty industry is much more fragmented and inefficient than traditional real estate, the opportunity still exists for returns in the 8-12% range.

While there are different risks that exist with oil and gas, many clients appreciate the non-correlated nature of energy ownership with their other holdings, including real estate and the stock market. The natural hedge against inflation that royalties provide is also a fundamental reason why many investors add this asset class to their portfolios.

Although a new concept to most real estate investors, oil and gas royalties have played a more predominant role in 1031 exchanges over the past 10-15 years.

“No Gain or loss shall be recognized on the exchange of property
Held for productive use in a trade or business or for investment is
Such property is exchanged solely for property of like kind which is
To be held for productive use in a trade or business or for investment”

There are two kinds of property that the IRS recognizes: Personal and Real property. Real property is land and the rights to that land both above and below the surface. Real property and Personal property will never be viewed as Like Kind property by the IRS.
“Like Kind” refers to the character of the property and not its quality. For this reason, all Real Property is considered Like Kind by the IRS. For property to qualify for a Like Kind exchange the property must have been held for an investment or for productive use, and the replacement property must be used for the same thing.
An individual wanting to exchange real property for oil and gas royalties, the property must be one held for income or investment purposes. An example would be a rental property used to generate monthly income.
Some property has been excluded from a Like Kind exchange by the IRS such as stocks, bonds, certificates of trusts are all not eligible for an exchange. This is because of the nature of these types of property as discussed earlier. However, these instruments in and of themselves are not real property so they cannot qualify for a Like Kind exchange, unlike oil and gas royalties.

Real Estate also offers a sense of protection against inflation from the market. Instead of fearing inflation, real estate investors and owners, in a sense, look forward to it. Property values inflate just like everything else in the market.

What few investors know is that Oil & Gas properties qualify as “Like Kind” for real estate investing. The IRS looks at Oil & Gas properties in the same way they look at an investment in real estate because they are both real property.

A type of exchange that many savvy real estate investors know about in the 1031 exchange. In 1954, the IRS passed an Act that allowed investors to defer their capital gains tax, so long as the money gained on the investment was re-invested into real estate.

What many are unware of, is that in 1968 the IRS published a clarification ruling titled Revenue Ruling 68-331. This clarification stated that real estate ownership interests, whether they are above or below the ground, qualify for the Like Kind Exchange. Investors can enter into an exchange from a real estate property above ground, into an oil and gas property that is below ground, such as owning minerals. Instead of rent revenue, investors begin to receive Royalty payments.